Sir Mervyn King: 'Why, you might ask, did the Bank of England not do more to prevent the disaster? We should have. But the power to regulate banks had been taken away from us in 1997.
Sir Mervyn King has admitted that the Bank of England should have "shouted from the rooftops" its concerns about the looming disaster in the City as he warned that Britain's recovery from recession would be a long, slow process.
The Bank's governor urged the coalition government to press ahead with reforms that would ringfence the high-street operations of banks from their speculative activities, after blaming the last Labour government for allowing the financial sector to take ever bigger gambles in the build-up to the financial crisis of 2007-08.
King said that the decision by Gordon Brown to strip Threadneedle Street of its powers to regulate banks had left him unable to do more than "issue reports and preach sermons" as the financial system became "increasingly fragile".
While accepting that "no one could quite bring themselves to believe that in our modern financial system the biggest banks in the world could fall over", the governor said the Bank had been aware of the precarious position of institutions that were lending too much.
"That isn't to say we were blind to what was going on", he said in the BBC Today Programme Lecture, adding that for several years the Bank of England and other central banks had warned that the financial markets were underestimating the risks they were taking.
"So why, you might ask, did the Bank of England not do more to prevent the disaster? We should have. But the power to regulate banks had been taken away from us in 1997. Our power was limited to that of publishing reports and preaching sermons. And we did preach sermons about the risks."
Looking back at the events since global financial markets froze up in August 2007, King said the Bank had not imagined the scale of the disaster that would occur when the risks it had identified crystallised. The crisis led to a three-day run on Northern Rock – the first on a British high street bank since the 1860s – and, a year later, the part-nationalisation of Royal Bank of Scotland and Lloyds Banking Group.
"With the benefit of hindsight, we should have shouted from the rooftops that a system had been built in which banks were too important to fail, that banks had grown too quickly and borrowed too much, and that so-called 'light-touch' regulation hadn't prevented any of this," King said.
"And in the crisis, we tried, but should have tried harder, to persuade everyone of the need to recapitalise the banks sooner and by more. We should have preached that the lessons of history were being forgotten – because banking crises have happened before."
The financial crisis led to the deepest slump in the UK output since the second world war, but King defended the Bank's handling of monetary policy in the pre-crash years. Recessions, he said, were supposed to follow booms and periods of high inflation: there seemed no reason in this case to expect the worst recession since the 1930s.
"In the five years before the onset of the crisis, across the industrialised world growth was steady and both unemployment and inflation were low and stable. Whether in this country, the United States or Europe, there was no unsustainable boom like that seen in the 1980s; this was a bust without a boom."
The governor was critical of a banking system that had "overextended" itself, noting that, by the end of 2006, the banks had borrowed £50 for every pound provided by their own shareholders. Problems were building in the banking system, he said, noting "on all sides there was a failure of imagination to appreciate the scale of the fragilities and their potential consequences".
King added: "In good times, banks took the benefits for their employees and shareholders, while in bad times the taxpayer bore the costs. For the banks, it was a case of heads I win, tails you – the taxpayer – lose."
The governor expressed strong support for moves to ensure that banks are better regulated, operate under a framework that ensures they can fail without harming depositors, and are restructured so that day-to-day banking services are kept distinct from "complex and potentially risky trading activities".
He said: "For the sake of future generations, we too must be bold and decisive and, while the memory is fresh, learn the lessons from this crisis. Reform is essential.
"We don't build nuclear power stations in densely populated areas; nor should we allow essential banking services and risky investment banking activities to be carried out in the same 'too important to fail' bank.
"Last autumn, the independent commission on banking, chaired by Sir John Vickers and comprising some of our most brilliant bankers and economists, published recommendations on how to do this. It's vital that parliament legislates to enact these proposals sooner rather than later."
Britain's economy is still more than 4% smaller than it was when activity peaked in the first quarter of 2008 and King said recovery was taking longer than expected.
"The present crisis is far from over, as events in the euro area illustrate weekly. Our own economy is still not back to health. Although inflation has fallen back in recent months, it is still too high. And despite efforts to stimulate the economy, the recovery is proving slower than we had hoped. It will come. But dealing with the consequences of our 'bad banking situation' is likely to be a long, slow process."
Although concerted action by the world's leading nations prevented a full-scale financial collapse in late 2008, King said that the bank bailouts came too late to prevent the financial crisis spilling over into the world economy.
"The realisation of the true state of the banking system led to a collapse of confidence around the world and a deep global recession. Over 25m jobs disappeared worldwide. And unemployment in Britain rose by over a million. To many of you this will seem deeply unfair, and it is. I can understand why so many people are angry."